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FRONT PAGE CONTRIBUTOR

Lee Fang on Oil Speculation: In Over His Head

Summertime 2011, and “investigative journalist” Lee Fang of ThinkProgress has replaced the BP Spill in my blogging life. Fang’s amateurish attempts to find scandal in oil commodities trading have become my new blog fodder.

This latest offering is especially sweet, because a key source Fang cites in support of his thesis – that financial speculation drives the market price of oil much higher than it would otherwise be – in fact takes the exact opposite position.

Does he assume that his readers are too lazy to read and too stupid to understand his sources? Or is Lee Fang just in over his head?

Fang says:

In December 2008, when oil prices crashed from record highes [sic] to $33 a barrel, speculators with the capability to store massive quantities of crude oil bought in bulk and stored the oil for later sale. As Fortune magazine reported, the rush to store oil instead of refining it pushed prices for consumers back up. Now, the contango — a market situation when the spot price is much lower than the future price of oil — is less significant than back in 2008.

Yes, it is less significant. The extraordinary circumstances of late 2008 do not exist in 2011. Oil crashed from $140 in July 2008 to $33 per barrel by that December. The futures market offered a $12/bbl profit to someone who could store oil for 12 months – a 30%+ profit. Now the contango is $3/bbl or less, so the profit on a $100 barrel is 3%, before accounting for carrying and storage costs. After those costs, buying oil to store it is probably a losing venture – especially if you’re paying to store it offshore in a tanker.

The subtitle of the linked Fortune article (from 2008) suggests that oil speculation “really is making oil more expensive”. That may have been true in the unprecedented market meltdown of late 2008, but it’s certainly not true now. Writer Jon Birger would obviously agree with me:

Today’s speculators [in late 2008] are actually buying oil. They’re not merely flipping futures contracts without taking delivery – which is what hedge funds and commodities index funds were doing when they were in the crosshairs of Congress this summer. As I’ve argued before, investors who trade futures but never take delivery of actual oil can’t have a material impact on oil prices because their trading affects neither supply nor demand.

[Emphasis added here and throughout.]

Fang has repeatedly railed against paper speculators as the culprits behind rising prices. The highlighted statement above directly refutes the idea that Fang and ThinkProgress have been pushing for months in their series of articles.

If trading moved the market in 2008 (I would argue instead that it stabilized a volatile market), that opportunity does not exist in 2011. The buyers of SPR oil are looking to store oil in tankers offshore, not to exploit the $3/bbl contango but because inventories are high and shore-based storage is full. (Which calls into question the urgency of this draw on our strategic reserve — with high inventories, where is the “emergency”? But that’s the topic of another diary…)

That Fortune article linked to another by Birger: “Hunting for Oil Villians” (from July 2008, when oil was $140/bbl), another direct refutation of Fang’s “speculators drive the market” thesis.

My own view is that speculators can’t materially impact prices if all they’re doing is making bets on the direction of oil prices by trading futures and not taking delivery of actual oil – hoarding stuff that would otherwise go to consumers.

People don’t fill up their tanks with futures contracts, and there’s no evidence investors are putting more oil into storage as a bet on higher future prices.

In still another Fortune article from the previous week (“Don’t Blame the Oil ‘Speculators'”), Birger ripped a Congressional investigation into speculation that Progressives cheered:

“Make no mistake about it,” U.S. Rep. Bart Stupak, D-Mich., said Monday while chairing a meeting of the House Energy and Commerce subcommittee on Oversight and Investigations. “Excessive speculation in commodity markets is having a devastating effect at the gas pump that is rippling through our entire economy.”

Here’s a suggestion: The next time a Congressional committee wants to hold a hearing on how “speculators” are driving up oil prices, each committee member should first be required to demonstrate – preferably in their opening remarks – a basic understanding of the mechanics of futures trading.

Even better, they should be required to explain in detail how it is that investors who never take delivery of a single barrel of crude – and thus never remove a drop of oil from the open market – are causing record high oil prices.

Lee Fang’s “Progressive” readership may be willing to take the mere existence of a link as supporting evidence, but every once in a while it’s good to click through and read those links. Rather than cherry-picking quotes that superficially support his argument, Fang might learn a thing or two about oil trading by actually reading the links he provides.

Postscript: The title of Fang’s article refers to the “discounted” price of SPR oil. In fact, the SPR sale was an auction and as such reflected the market at that point in time. Obama’s release of SPR oil did drive prices down, but very temporarily. Auction buyers were accepting the risk that the release would drive prices lower still; after all, that was the stated intent of Obama and the IEA. As it happens, the buyers will enjoy a quick profit on their purchases, since prices closed higher today than before the release was announced. Oil prices were only “discounted” by the Administration’s attempt to tinker with the market; we’ve already seen how successful that was.